It’s important that we remember that the charts and studies we use are representation of buying and selling; buying and selling that is the result of human action. Therefore, charts are nothing more than a visual representation of the prevalent dominant buying or selling psychology. Sometimes we get so carried away with patterns etc that we forget this is so. Thinking in terms of the dominant psychology, provides trading opportunities especially for short-term trades and entries for longer-term ones.

In this blog, I want to illustrate this idea with reference to my blog S&P VI and last night’s price action.

On January 30 we were awaiting the FOMC decision. The 0.50% was anticipated by most. Readers of this blog know that more often than not, I tend to take a position against the crowd. But in this case, I could not see how Bernanke and Co would not cut by at least 0.50%.

  • The FED’s reaction to the turmoil - brought about by the Societe Generale’s liquidation of positions - meant that if the FED cut less than 0.5%, the market would probably tumble because the FED is now perceived to be reacting to financial markets rather than the US economy.
  • Since the majority was expecting a 0.50% cut, the immediate response would be a rally as the crowd piled into the US stock market.
  • Since the US stock market is probably in the first phase of a bear market (what Wyckoff and Tubbs called a Distribution Phase), the rally would be met by professional selling at resistance points. I was lucky enough to identify such a possible point at 1382 to 1386 basis cash S&P.

The same sort of thinking again provided opportunities yesterday.

The market gapped down on the open. Now, bearing in mind that we have Non-Farm Payrolls today - in my view this is currently the KEY monthly number - what would a short-term professional do if he had gone short the night before? Would he carry his entire position into tonight’s figure? Unlikely in my view.

His tendency would be to take at least some profits. The crowd would see the rally and would probably initiate long positions. Since there would not be serious opposition to the buying, and we might even see some stops go off, we could expect a rally to last most of the day.

Based on this reasoning of the psychology of the markets, I anticipated that the market would cover the gap and, if the market would accept above the bottom of previous day’s Value Area, we’d probably see the other side of the Value Area. In addition we could anticipate the range for yesterday once we accepted above the bottom of the Value Area. We do this by adding 59 to 33 to the low. (Mean, 42, + 17 [1 stdev] and -9 [1/2 stdev]; this is the mean of true range and ‘+1 std to - 1/2 std’ measured from the time  volatility increased).

This was the game plan a couple of my day-trading students developed and they implemented it by leaning against the gap open in the “B” period with stops below the low of ‘A’. They planned to take partial profits at or slightly above bottom of the prior day’s Value Area and the rest at the position was to be liquidated around the top of Value. This was on the proviso that top of the Value Area from the low did not exceed mean +1 i.e. 59 points. (It didn’t).

Figure 1 illustrates the strategy.

es-02-01.jpg

FIGURE 1 Market Profile Data

Tonight we can apply the same reasoning. I’d be less of a contrarian tonight for these reasons:

  1. I judge that even the professional would need to see more evidence of a top.
  2. Apart from last night, the crowd has been burnt, so I’d expect that they too need to see some confirmation.

The consensus for the Unemployment Rate is 4.9% with a range of 4.9% to 5.0%; the Non-Farm consensus is 58k with a range of 25k to 120k (http://www.nasdaq.com/asp/econodayframe.asp?page=http://www.nasdaq.com/econoday/index.html). So for tonight:

  • If the figures are around consensus say 75k to 50k range I’d expect a quiet night - after an initial flurry - and expect an unchanged close.
  • A figure of above 120K would be bearish for the S&P and bullish for the US$. I’d expect to see a lower close.
  • A figure below 25K would be bullish the for S&P and bearish for the US$. I expect to see a higher close.

What would be my trading strategy?

First I want to repeat what I have been saying in previous threads. The ES ranges are too rich for my blood. I’d be standing aside. If I had to trade, I’d have a sell-stop below the market and below Delta support; at the same time, I’d have a buy stop above the market and above Delta support.

I’d be looking for a smaller or larger range than consensus for N-F to trigger my entry. BTW, for this sort of trading to be successful, it’s a given that you know from previous experience that you are unlikely to suffer much slippage).

If an entry is triggered without the N-F payroll aligning with entry, I’d exit immediately wherever the market may be trading. If the N-F conditions align with the entry, I’d exit 50% before 9:30 EST if I can pocket 10 points. The remaining 50%, you’ll have to manage. If I don’t get my 10 points, I’d consider exiting before the opening bell on the basis that generally the market will cover an opening gap.

Take it easy, it may get rough out there tonight.

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